Senator Bunning’s Office Responds

I received an email on Thursday from Senator Jim Bunning’s legislative director, William Henderson. Unfortunately, it was sent to my secondary account, and I didn’t notice it until this evening when I returned home from a weekend trip. I feel it’s only fair to post Mr. Henderson’s email in full, as it is a response/clarification/enhancement to the post I wrote last week titled “Emergency Powers.” And oh, Mr. Henderson – if you ever want to contact me, drop me a comment on my blog. It’s a much quicker way to get in touch with me, and I’m happy to provide further input on the policies you guys are looking at.

Without further ado:

KD, I enjoy the blog and am a regular reader. It has been helpful as we have been working on the financial reform bill and, most recently, the stock plunge hearing today.

I wanted to clarify what Sen. Bunning’s comments regarding emergency powers at the hearing today. His point was that the SEC and the exchanges have identified some changes they think should be made (the new trading curbs) but those changes are not yet in place and able to be used because the SEC’s rule approval process takes a couple weeks. He was inviting Schapiro to ask for the ability to make such changes faster if she thinks that is appropriate. That is what he meant by emergency powers.

Regarding market orders, he agrees with you. I’ll paste an exchange that started with Eric Noll of NASDAQ and Larry Leibowitz of NYSE Euronext on breaking trades and ended with a bit on market orders.

Finally, he said at the beginning of the hearing that he was glad to see the curbs are for moves in either direction, and not just down.

Hopefully this will allay your concerns a bit.

W

Mr. Henderson also included the exchange to which he was referring:

“Transcript:

BUNNING: It’s all right. Thank you.

Mr. Noll, I’m going to start this question with you, since you talked about it more in your written statement than anyone else. But I would like the others to respond as well.

As I said in my statement, I am concerned about the way some trades were canceled. Given that everyone seems to agree the system worked the way it was set up to do, how do you justify canceling trades and protecting sellers from their bad decisions?

NOLL: I — I share much of your concerns, Senator Bunning. And it was a very difficult day to make that decision. It was done in coordination with all of the other markets on an ongoing discussion and, quite frankly, lasted many hours trying to decide what the appropriate decision was fair.

So we were trying to balance the need and requirement of what we would call moral hazard issues, which is making people aware and bear the consequences of their activities in the marketplace for good or for ill, with what was clearly a dysfunctional marketplace that wasn’t functioning as it should function.

So in the absence of any clearly erroneous trade, we looked at the DK of what we would call price discovery and the provision of liquidity.

NOLL: And we tried to draw that line — admittedly somewhat more arbitrarily than I think any of us are comfortable with — draw that line in an appropriate area where we did not reward anyone for bad behavior, but we did solve the problem of what we considered to be a dearth of liquidity.

That being said, I think we are very confident that the stock-by- stock circuit-breakers that we’re putting into place will prevent a reoccurrence of this kind of situation.

BUNNING: Looking back, we all have 20/20.

NOLL: I think that’s true. So we — we — we believe that we’d like to put the stock-by-stock circuit-breakers in place. We think that will prevent this going forward, these kind of events going forward, but more importantly, we endorse Chairman Schapiro’s desire that we have transparent, understandable, agreed-upon across all markets trade break clearly erroneous rules that remove the discretion from any one market actor or any group of market actors so that everyone knows visibly and clearly what those — what those events are and how they will be triggered.

BUNNING: Anybody else like to jump in? Go ahead.

LEIBOWITZ: Sure. Sure. So I had the fortune of sitting on the Nasdaq Quality of Markets Committee at the time that the first erroneous trade policy went in. And I think, Rick, you were actually…

KETCHUM: I was there.

LEIBOWITZ: … the CEO at the time or the COO at the time. And it troubled me then, and it troubles me now. Markets that have to resort to breaking trades as a response to abhorrent (ph) conditions are — are — are just not orderly markets, in my mind. It’s not the way we should do our business.

I think, in this case, the big challenge wasn’t we had institutional investors who made a mistake. You know what? You’re right. They should pay the price.

The challenge here was that we had retail investors who had submitted market orders that essentially went into a black hole. They had stop-loss orders in high-cap stocks…

BUNNING: But — but I’m sorry, sir. Sophisticated — even if they’re not sophisticated, anybody that puts a market order in knows exactly what’s going to happen to a market order.

LEIBOWITZ: So I would agree with you that their broker probably does — and maybe the answer is the broker should have stood up (ph) for that trade — I would submit to you that a lot of the public does not. And I’ll tell you…

BUNNING: A lot of the public doesn’t know that if you put a market order in, it’s executed?

LEIBOWITZ: They think, maybe it’ll go — it’ll go — you know, I’ll be…

(CROSSTALK)

BUNNING: Rather than a limit order?

LEIBOWITZ: Well, they don’t realize that, when I trade Accenture, it’s going to be down 99 percent when they get now.

BUNNING: I agree with that.

LEIBOWITZ: And — and…

(CROSSTALK)

BUNNING: But if you put a market order in, that’s your execution.

LEIBOWITZ: You’re absolutely right in that regard. And I think we have to make sure that it just can’t happen in the market. We also need to talk about whether market orders should be allowed at all and how we educate people so these things don’t happen.

But I agree. There should not be the moral hazard of breaking trades. It is not the right way to make a market function properly.”

It’s good to see that Bunning understands exactly what a market order is, and I agree with Larry Leibowitz that the retail public does NOT understand exactly what a market order is, and that reform is needed to either educate the public so that there is no whining and there are no “victims” after the fact, or to simply protect Joe Retail from himself by preventing him from entering market orders.

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